Bonds: Investing in Debts
Bonds are increasingly viewed as a key component of a financial portfolio
Issue: Feb 2011
CapitaMalls Asia’s recent bond offer was 1.82 times oversubscribed
In Jan 2011, CapitaMalls Asia (CMA) launched a S$200 million bond offer. Comprising of one-year bonds that pay one per cent a year and three-year bonds that pay an interest rate of 2.15 per cent per annum, the bonds were issued in denominations of $1,000, although the minimum subscription is $2,000. The low quantum made the bonds readily accessible to retail investors, and attracted strong interest. The public offer was approximately 1.82 times oversubscribed. The strong debut is no surprise, given that bank deposit rates are much lower, at around 0.35 per cent for one-year term deposits. The ample liquidity in the region looking for higher yield also helped boost demand.
The CMA bond offer came hot on the heels of Singapore Airline’s bond offer in October 2010, which was the first ever bond offer targeted at retail investors in Singapore. In Nov 2010, DBS Group Holdings followed with $800 million in new preference shares to retail investors, which was more than 3.5 times oversubscribed. The strong reception by retail investors to the bond offers showed that retail investors are becoming more receptive to this asset class.
What is a Bond?
A bond is a financial debt security, in which the authorized issuer owes the bondholders a debt and is obliged to pay a pre-determined rate of interest (known as coupon) depending on the terms of the bond and/or to repay the principal at a later date (known as maturity). For instance, if an investor buys a bond with a $1,000 face value, at 5 per cent coupon which matures in 10 years, he would collect interest payments of $50 every year for 10 years, and thereafter get back his principal sum of $1,000.
Bonds vs Stocks
Although both bonds and stocks are securities, bonds are different in that:
- Bondholders will only have a creditor stake in the company (as lenders) whereas stockholders will have an equity stake (as owners). In other words, stockholders would enjoy voting rights and also the right to share in any future profits but there are no promises on dividends or returns. However, bondholders do not share in the profits if a company does well as he or she is entitled only to the principal plus interest. In the case of a bankruptcy, bondholders can enjoy a higher claim on assets than shareholders as he will get paid before a shareholder does;
- Bonds have a defined term/maturity which is usually redeemed upon maturity whereas stocks can be held indefinitely (with the exception of a consol bond which has no maturity).
To sum up, an investor would generally be exposed to less risk in owning bonds than in owning stocks, but at the expense of a potentially lower return.
Many retail investors typically shun the bond market because of a lack of familiarity. Bond issues are usually targeted at institutional investors and so are normally in large denominations between $200,000 - $250,000. Hence these are generally out of reach for the retail investors. Bonds also generally lack the same level of potential upside as the stock market. Many retail investors would rather buy stocks when they want to go for gains, and when fearful for market losses, they turn to capital protected funds or hold onto cash instead.
However, for investors looking for stability and steadiness, bonds fit the criteria better than most other financial instruments. Bonds provide regular payments, or coupons, and can be the right instrument for investors looking for a steady stream of income. Bonds are also suitable for investors with low risk appetite, as they get their principal back in full when the bond matures, except in rare cases when the company defaults. In addition, bonds have an important diversification effect for any investor’s portfolio, as bond prices generally tend to move in the opposite direction vis-à-vis the stock market.
Given the enthusiastic reception of the retail investors to the recent bond offerings, it is likely that more and more companies will tap this new pool of funds. This creates a win-win situation in which companies can diversify their sources of funding, while retail investors can invest directly in bonds and in the process create a more diversified portfolio for themselves.
Article contributed by Andrew Soh, Senior Manager, Knowledge Management & Corporate Planning, CapitaLand Limited